Reflation

First, Geithner announced a plan of private-public partnership where in private players bear initial 15% of losses taxpayers bear the remaining share of the pie. Then, FASB changed the rules of the game to do away with mark-to-market accounting. Well done folks! This is a game changer – well, what you’d otherwise call for changing rules of the game in the middle of the game?

The real change won’t come from accounting changes but will come as a result of Geithner’s PPIP. This program will create trillions of dollars worth of demand for these toxic securities in an environment that could have very little supply. Most assume that the prices for these toxic assets will rise from .22 on the dollar up to as high as .60 on the dollar. I think these estimates are too conservative. With Geithner’s plan these assets will return to much higher levels…even approaching a full 100 cents on the dollar as housing stabilizes and investors return to the space.

Is it just a false optimism or is it bit disingenuous?

MBSes are backed by houses whose asset value has declined substantially and there is no way these ‘toxic’ MBS are going to come to a level of full dollar. Although, I agree that uncle sam will manage to inflate and bring the asset prices above its current depressed state.

We always had bubbles and investment mania in the world. Even in the 19th century, under the gold standard, from time-to-time investment manias and bubbles developed in railroads and in canals and in real estate, just to name a few. Under a fixed monetary, or gold, standard, where the quantity of money cannot be increased indefinitely; there is a natural limit to the scale of the crisis. Usually when there’s a boom in one sector of the economy, you have some kind of deflation somewhere else; that was also the case in the 1970’s. We had a boom in commodities, but bond prices collapsed.

What Mr. Greenspan and Mr. Bernanke have achieved is historically quite unique. They have managed to create a bubble in everything, everywhere in the world: in real estate, equities, commodities, art, worthless collectibles; even bond prices continued to rise as interest rates fell due to the loose monetary policy. Since 2007 and 2008, everything has collapsed.

But government bond prices continue to rise, and went ballistic between November 2008 and December 2008, when 10- and 30-year Treasury yields collapsed. So my view would be that this was the last bubble they managed to inflate. From here on, the government bond market will fall. In other words, the trend will be for interest rates to actually go up.

If inflation returns, the only place you want to be is in hard commodities – oil, gold, copper, steel, agri.

About

08 November 2008
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It’s 08Nov08 today. The financial crisis, which started with housing meltdown in US, has unfolded itself massively on global scale. This diary is an attempt to present the events as and when they happen from now onwards. I will try to keep it as factual as possible and looking to update it at least once in a week.
I am not an economist, so hoping to get layman’s common sense perspective on events of the crisis.
Crisis Diary as it unfolds …